AM Best warning over FTX collapse
The collapse of FTX, the Bahamas-headquartered crypto currency exchange, highlights the importance of effective corporate governance, including in the insurance industry, a leading credit ratings agency has said in a commentary.
In Corporate Governance Lessons for Insurers in the Wake of the Failure of FTX, AM Best notes that although FTX is not an insurance company, the series of events leading to its collapse should nonetheless provide a sobering warning for the insurance industry.
FTX, founded and led by Sam Bankman-Fried, and its related entities filed for bankruptcy protection in Delaware early last month.
The ratings agency said it typically takes a favourable view of an insurance company’s enterprise risk management frameworks which incorporate lessons learnt from recent events and emerging issues.
Equally, AM Best said it expects insurers with strong governance practices to be better able to manage risks.
The commentary notes that FTX did not have a board of directors.
“An experienced, informed and independent board is vital for effective governance practices to ensure insurance companies are run and challenged in an appropriate way,” said Michael Dunckley, director, analytics, AM Best.
“As part of its ratings process, AM Best seeks to assess the substance of an insurer’s governance, as well as its stated policies. The board should be able to effectively hold senior management to account and ensure that stakeholders’ interests are protected.”
AM Best said FTX’s revenue grew by more than 1,000 per cent during 2021.
For insurance companies, it said, although high premium growth may not always be a danger sign, rapid growth can be an indication that an insurance company has underpriced business to gain market share or has expanded into an unfamiliar product line — both of which may lead to underwriting losses.
It added that such high growth can be a result of poor strategic decisions associated with weak corporate governance.
Ultimately, the commentary states, FTX suffered from a concentration of power in the hands of a single individual, combined with a lack of experience among its senior management team.
It said a lack of transparency with external parties in terms of financial reporting or making misleading public statements is a powerful indicator of poor corporate governance and can precede a substantial decline in a company’s financial strength.
AM Best said it incorporates an assessment of regulatory environment into credit rating analysis, particularly through the assessment of country risk, and believes that well-developed and effective regulatory regimes put a strong focus on effective corporate governance.